Figure 1: Labor Market Effects of Offshoring - The Sector Bias
equilibrium, production takes place at points A and B, where the unit value isoquants
Q interact with the relative price line wL/wH. The Y industry produces at point B with
the use of two intermediate products YH (relative high skill intensive) and YL (relative
low skill intensive).
Now suppose that, e.g. due to advances in technology and communication, off-
shoring gets possible and that the low skill intensive industry (e.g. the import com-
peting one in a high skill abundant economy) relocates production of its relative low
skill intensive intermediate abroad and imports the respective input instead. Thus, do-
mestic production of Y consists solely of production of the relative high skill intensive
component YH . At the initial relative wage ratio, factor intensity in the Y industry shifts
to the more high skill intensive expansion path YH (let’s call this the "offshoring-effect").
While the relative price of Y remained unchanged, overall costs decrease due to the
lower-cost procurement of the foreign country, shifting the unit isoquant inward to
Q‘Y . However, due to this decrease in costs, the unchanged relative price of Y is now
inconsistent with the initial relative wage ratio. Therefore, Y producers increase the
relative demand for low skilled labor (since it is the relative low skill intensive indus-
try). Relative wages of the low skilled increase as long as the new ratio is tangent to
the new isoquant Q‘Y, resulting in the new equilibrium of production at A‘ and B‘ (let’s
call this the "wage-effect"). As can be seen with the new expansion paths X‘ and Y‘, the
combination of the "offshoring-effect" and the "wage-effect" induces skill shifts in both
industries towards more high skill intensive production patterns. The framework can